


Covered calls

by Mad4Real



Category: Original Work
Language: English
Status: Completed
Published: 2020-05-24
Updated: 2020-05-24
Packaged: 2021-03-02 17:21:05
Rating: General Audiences
Warnings: Creator Chose Not To Use Archive Warnings
Chapters: 1
Words: 360
Publisher: archiveofourown.org
Story URL: https://archiveofourown.org/works/24360487
Author URL: https://archiveofourown.org/users/Mad4Real/pseuds/Mad4Real
Summary: N/A





	Covered calls

For a covered call, the call that is sold is typically out of the money (OTM), when an option's strike price is higher than the market price of the underlying asset. This allows for profit to be made on both the option contract sale and the stock if the stock price stays below the strike price of the option.

Rolling a covered call

Imagine you’re running a 30-day covered call on stock XYZ with a strike price of $90. That means you own 100 shares of XYZ stock, and you’ve sold one 90-strike call a month from expiration. When you sold the call, the stock price was $87.50, and you received a premium of $1.30, or $130 total, since one contract equals 100 shares. Now, with expiration fast approaching, the stock has gone up to $92. In all probability you will be assigned and have to sell the stock at $90.

The only way to avoid assignment for sure is to buy back the 90-strike call before it is assigned, and cancel your obligation. However, the 90-strike call is now trading for $2.10, so it will hurt a bit to buy it back. To help offset the cost of buying back the call, you’re going to “roll up and out.”

That means you want to go “up” in strike price and “out” in time. The idea is to balance the decrease in premium for selling a higher OTM strike price versus the greater premium you’ll receive for selling an option that is further from expiration (and thus has more “time value”).

Here’s an example of how that might work, you enter a buy-to-close order for the front-month 90-strike call. In the same trade, you sell to open an OTM 95-strike call (rolling up) that’s 60 days from expiration (rolling out). Due to higher time value, the back-month 95-strike call will be trading for $2.30. Since you’re paying $2.10 to buy back the front-month call and receiving $2.30 for the back-month call, this trade can be accomplished for a net credit of $0.20 ($2.30 sale price - $2.10 purchase price) or $20 total.


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